The Development of Capital Market in Cambodia 1

Seminar on Bond Market Development

17- 18 March 2005, Bangkok, Thailand

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I. Introduction

The Royal Government is conscious that an economy will not reach its growth
potential and develop at an adequate pace, without an active contribution from
the financial sector. Therefore, the government is committed to strengthening
the financial system and, over the recent years, has been enacting legislation,
adopting policies, creating institutions and adapting procedures as part of the
financial sector reforms in order to quicken the pace of economic growth.

Financial sector development is important to the speed and direction of economic

growth, since a strong and well-functioning financial sector can break down the
limitations of self-financing, mobilize idle financial resources for productive
investment needs. To link up saving, investment and economic growth, the
financial sector development must go together with private sector development
and governance, forming one the three pillars to support the government policy
of generating growth, which is seen as the major means to reduce people
poverty, the ultimate goal of the government economic policy.

II. Financial Sector Development Blueprint

The Royal Government of Cambodia, with the assistance from the Asian
Development Bank, developed the Financial Sector Development Blueprint 2001-
2010, which provides a roadmap to reform and develop the country's financial
systems as a necessary precondition to liberalization.

The Royal Government adopted on the 24th August 2001 a financial sector
blueprint called «Vision and Financial Sector Development Plan for 2001-
2010», which forms part of an overall government reform agenda toward
establishing a more market-based, open, and private-sector led economy. With
the blueprint, each important component of the financial sector that is being

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This paper is prepared by Dr. Hang Chuon Naron, Secretary General, the Ministry of
Economy and Finance of the Kingdom of Cambodia for the Seminar on Bond Market
Development held on 17- 18 March 2005, Bangkok, Thailand.

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developed or will be developed by individual and separate efforts of the relevant
organizations have been coordinated, streamlined in a handed and systematic
manner and reflected in one document.

The blueprint envisages the development of a sound, market-based financial

system in ten years that will enhance resource mobilization and sustainable
economic growth. It addressed relevant sub-sectors to be developed within a
period from 2001 to 2010. That is, in ten year from now, Cambodia will have:

• First, a competitive, integrated, and efficient banking system that is

properly regulated and supervised and effectively mobilizes savings to
provide financing to support the growth of the private sector, a reliable
payment system and a banking safety net.

• Second, a viable, pro-poor and effective rural finance system for providing
affordable financial services to enable the poor to enhance rural income
and reduce poverty.

• Third, an insurance sector that protects businesses and individuals from

catastrophic events and a pension system that provides a secure
retirement, both of which provide capital for long-term investment in the
real sector.

• Fourth, diverse non-banking financial products and institutions that create

more balanced financial structure, increase the depth of financial market,
and promote competition. These include leasing business, money market
and capital market intermediaries, and development finance institutions.

• Fifth, a money market that enables an inter-bank market that provides

banks, companies, and individuals with the means for effective liquidity
managing.

• Sixth, an efficient and transparent capital market with a critical mass of

issuers that mobilizes funds for long-term investment.

• Seventh, legal and accounting systems that promotes the rule of law in
commercial and financial transactions and support good governance by
promoting transparency, accountability, and predictability.

The Financial Sector Development Plan also emphasizes, in addition to the

institutional and legal strengthening of the financial sector, the need to develop a
reliable financial information system and to introduce an efficient mechanism to
build up manpower capable to face with the future challenges.

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To ensure its successful implementation, the blueprint has been structured as a
step-by-step plan. Intermediate reform agenda has been formulated to help
identify specific measures and to set the sequence and pace for the
implementation of those measures. Another important feature of it is the built-in
flexibility within the reform agenda, which allows the government to make
necessary policy adjustment to reflect progress made along with the changing
conditions.

2.1. Conditions for Capital Market Development

Foundation for capital market development:

(i) A sound fiscal policy and price stability (ii) public confidence in the protection
and security of property rights and contract enforcement. (iii) Rule of law,
supported by an appropriate legal/judiciary system and law enforcement. (iv)
Financial market infrastructure, particularly an accounting and auditing system,
credit information system, and regulatory framework. (v) Sound competition (vi)
A sound financial system builds on sound governance principles and strong
market discipline (vii) State ownership of financial institutions (x) market-
oriented management

Developing Capital Market Intermediaries. First, the Government needs to

establish regulations on securities brokers/dealers, targeting the first candidate
group of financial institutions. Government should also establish a legal and
regulatory framework for (i) securities companies/subsidiaries, investment
advisory companies, and securities finance companies; and (ii) banks to establish
securities subsidiaries.

Developing Institutional Investors for Capital Markets. Regulatory

framework for trust business in banks, investment/management trust companies,
mutual funds, venture capital companies.

Establishing DFIs to Promote Medium and Long-term Lending. In the

third phase, the Government should provide a legal and regulatory framework
for medium- and long-term export-import credit institutions and other DFIs.

The sequencing and pacing in money market development need to be aligned

with development of the banking and non-banking sectors:

• The first phase aims to establish the foundation for short term unsecured
interbank markets and to provide a base for interbank/money markets
through the issuance of T-Bills and the promulgation of a negotiable
instruments law.

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 • The second phase will strengthen interbank markets, establish regulations
such as negotiable certificates of deposit and repurchase agreements, and
develop a primary dealer system and regularize the issuance of T-Bills.

• The third phase aims to broaden the interbank/ money markets with a
regulatory framework for non-financial issuers of money market
instruments such as commercial paper.

Establishing Interbank Market Arrangements for the Banking Sector.

The establishment of an inclusive bankers association will allow it to play a
catalytic role in the formation of the interbank markets. The first interbank
service can be short-term unsecured interbank lending (overnight call loan and
money).

Creating an Enabling Environment for Money Market Development. The

first task is to adopt a negotiable instruments law. Second, NBC should set up a
regulatory framework for the interbank market activities of commercial banks.
Third, NBC should provide detailed procedures for issuing interbank/money
market instruments.

Creating an Enabling Environment for T-Bills. The Government issued in

2003 T-Bills through competitive auction. The Government also needs to adopt a
medium-term plan to develop a T-Bill market.

Expanding the Scope of Interbank Markets. With the availability of T-Bills

and other government securities from the second phase, the money markets will
be able to accommodate small banks and NBFIs by providing an interbank
repurchase arrangement based on T-Bills and other government securities.
Develop a standardized contract for repurchase agreements and supporting
regulations.

2.2. Capital Market Development

The capital market development plan consists of three sequenced development

goals. During Phase I, the Government is expected to accomplish the necessary
preparatory work to create an enabling environment for capital markets. In the
second phase, it is envisaged to establish the foundation for capital markets by
establishing a securities exchange and the necessary infrastructure related to
securities trading, as well as by adopting detailed regulations and procedures.
Building on the preparatory work up to the second phase, it is expected that the
Government will make systematic efforts to develop capital markets in Phase III.

Establishing a Key Legal/Regulatory Framework. Preparatory work for

capital market development. Second, the Government should develop a master

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plan for creating a functional capital market framework. Third, the Government
must conduct a feasibility study to assess the existence of a critical mass of
potential securities issuers. Fourth, the Government needs to draft a securities
and exchange law. Finally, Determine the basic structure of exchange regulations
such as listing requirements, auction rules for trading, corporate disclosure, and
exchange membership.

Creating an Enabling Environment for Public Bond Markets. Along with

the issuance of T-Bills, the Government should exert effort to develop diverse
public bonds markets.

Building Capacity for Future Capital Market Participants. Conduct

capacity-building activities for a wider group of stakeholders of capital markets.
The first and urgent group to train the future regulators and players in capital
markets.

Building on the preparatory work and achievements in the first phase, the
Government can establish a securities market in the second phase: (i)
establishing a capital market surveillance framework, (ii) establishing a securities
exchange, (iii) promoting the issuance of public bonds, and (iv) strengthening
capacity building for the public.

Establishing a Capital Market Surveillance Framework. Establish a

securities market supervision and surveillance body: two options for the
supervisor: (i) a capital market surveillance unit under the related line ministry,
or (ii) a full-fledged SEC.

Establishing a Securities Exchange. Design of the management structure of

the securities exchange, membership and board of directors, trading system, and
surveillance mechanism.

Cambodia needs to establish:

• a computerized exchange trading system, taking advantage of new
technology as a latecomer.
• a trading infrastructure such as a securities depository system and a
clearing system.

Promoting the Issuance of Public Bonds. Establish or refine the related

legal and regulatory frameworks. Creating a proper demand base for the public
bonds market is also crucial in the early stages. Thus, the Government must
consider an incentive system to create a demand for public bonds.

Strengthening Capacity Building for the Public. The Government should

continue to conduct comprehensive public awareness activities. In this phase,

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the Government may need to publish a detailed master plan to create a
securities exchange and provide general guidelines for listing requirements.

To accomplish this goal, four intermediate actions are needed: (i) strengthening
capital market supervision and surveillance, (ii) promoting capital market
participation, (iii) developing private bonds markets, and (iv) strengthening
capacity building activities for capital market participants.

Promoting Capital Market Participation. The Government needs to adopt

carefully designed incentives to encourage firms to go public, while bearing in
mind the potential adverse selection problem. The Government should also
promote sound governance principles for listing companies to promote investor
confidence.

Developing Private Bonds Markets. Adopt a comprehensive plan to develop

corporate debt markets. The Government should provide a legal and regulatory
framework for the large commercial banks and DFIs to issue bonds. In addition,
The Government also needs to support the development of a trading system for
fixed-income securities.

Strengthening Capacity Building Activities for Capital Market

Participants. Establishing a capital market training institution. Promote the
establishment of a securities brokers and dealers association as a capital market
self-regulatory organization.

The development of legal infrastructure targets three reform agendas as follows:

(i) Phase I: creating the legal infrastructure to underpin financial sector
development, (ii) Phase II: strengthening law enforcement, and (iii) Phase III:
enhancing the legal infrastructure for private sector development.

Creating the Legal Infrastructure to Support Financial Sector

Development. In the first phase, the Government is expected to establish key
laws underpinning financial sector and private sector development. These include
civil code, company law, bankruptcy law,
secured transactions law, commercial contract law, and commercial arbitration
procedure.

Strengthening Law Enforcement. This includes (i) continuing judiciary

reform, (ii) establishing a commercial chamber in the court system, (iii)
developing and adequate compensation scheme and capacity for commercial
court jurists, and (iv) establishing a public registry for secured transactions.

Enhancing the Legal Infrastructure for Private Sector Development. The

Government’s effort to reform the judiciary system to support private sector

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development will be completed in the third phase. The Government needs to
adopt a legal/regulatory framework for a public registry for movables.

Development of accounting and auditing system consists of a three-phase reform

agenda over 10 years as follows: (i) Phase I: establishing accounting and
auditing standards and an enforcement system, (ii) Phase II: strengthening
enforcement of accounting and auditing standards, and (iii) Phase III: enhancing
the enforcement of accounting standards.

2.3. Financial information system

Phase I: creating a financial market information system; Phase II: expanding the
scope of the arrangements for sharing information among members of the
Bankers Association, and Phase III: diversifying and upgrading the market
information system.

Creating a Financial Market Information System. Establish arrangements

for sharing information among members of the Bankers Association to support
the banks’ credit operations. NBC must provide a regulatory framework
governing integration of credit information from commercial banks.

Expanding the Scope of the Arrangements for Sharing Credit

Information. In the second phase, the arrangements for sharing credit
information should allow the participation of other financial institutions upon their
emergence and the diversification of financial services.

Diversifying and Upgrading the Market Information System. Further

develop financial information systems by introducing diverse information
infrastructure. This includes the development of a financial sector database
industry and a credit rating agency to support debt markets.

Financial safety is required to enhance public confidence in the financial system.

This includes a two-stage reform agenda:
(i) Phase II: enhancing the banking sector safety nets; and
(ii) Phase III: expanding the financial sector safety nets.

Enhancing the Banking Sector Safety Net. The Government first needs to
establish the banking sector safety nets, which includes (i) introduction of a
deposit insurance system for the banking sector, and (ii) adoption of corporate
governance guidelines for banks.

Expanding the Scope of the Deposit Insurance System into the

Nonbanking Sector. Government may need to establish a separate deposit

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insurance corporation, independent from the central bank, to avoid conflict of
interest.

However, the timeframe set in the Financial Sector Blueprint, is an ambitious

one. It may not be realistic to expect to comply with the time targets of the
Blueprint in all areas of development.

III. The Banking Sector

The banking sector in particular needs strengthening, given its current low level
of development and its dominant position in the present financial system.
Cambodia's banking system was thus transformed from a mono banking into a
two tier banking system by separating the central bank functions from
commercial banking activities. To support the reform, legislative framework has
been improved. The central bank law was promulgated in January 1996,
providing better clarification of the Bank's status, ownership and capital
structure, and laying a more solid foundation for its operations. Along with re-
defining the new role of the National Bank of Cambodia (NBC), the government
is fully aware of the need to address the remainders of the financial system with
a view to establish a modern and efficient financial sector. The Law on Banking
and Financial Institutions, enacted in November 1999, represents therefore a
great asset for the nascent financial sector. This new law responds to the need
to promote a sound financial structure and orderly financial markets by providing
appropriate legal framework for the licensing, organization, operation, and
supervision of a broad range of financial services companies. In addition, the
Insurance Law was passed in June 2000.

Substantial efforts have been undertaken to improve prudential and

administrative regulations aimed at supporting the supervisory implementation of
the Banking and Financial Institutions Law. This includes the setting of prudential
limits for capital adequacy, solvency, liquidity and other parameters which form a
regulatory framework for the banking sector. The NBC will consider additional
regulations to ensure policies and procedures related to granting of loans and
making investment, evaluating the quality of assets and the adequacy of loan
loss provisions and reserves and write-off of bad debts, information systems, risk
management systems and internal control systems. As part of prudential
regulation, commercial banks are required to recapitalized from US$5 million to
US$13 million and undergo a re-licensing process.

Lack of human resource capacity and key legal infrastructure, as well as weak
public confidence is a major impediment to the development of the financial
sector. The lack or inadequacy of laws pertaining to accounting, insurance,
negotiable instruments, secured transactions, commercial enterprises,

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bankruptcy, contracts and commercial credit, also hamper the effective
functioning of the financial sector. To address these bottlenecks, the RGC has
taken strides to upgrade banking supervision capabilities and introduce a modern
payments system. Dollar clearing and settlement was initiated from January
2001 to facilitate payment operations and shorten availability times. To this end,
a draft Payments Law is being prepared by the NBC to provide a legal basis for
the payment system. An inter-bank market arrangement will be established to
ensure sound liquidity management. Moreover, the RGC is determined to adopt a
comprehensive commercial code by the end of 2002.

As part of the policy to strengthen the banking system and corporate

governance, the NBC proceeded to implement bank re-licensing, in compliance
with the Law on Banking and Financial Institutions, with a view to closing
inactive banks. The re-licensing of commercial banks is designed to establish a
viable banking system, promote savings and instill public confidence in the
banking sector. Four viable banks and 15 potentially viable banks were re-
licensed and Memoranda of Understanding, which detail the timetable for capital
injections and corrective actions, were signed with the potentially viable banks.
Eleven nonviable banks will be liquidated. Of these, seven banks applied for
voluntary liquidation. Independent auditors are nominated for the liquidation of
these closing banks. With these actions, the government has in mind to bring up
all existing banks to a higher standard, improving the soundness and reliability of
the banking system, which is crucial for confidence building.

The state-owned Foreign Trade Bank (FTB) has also been subjected to the bank-
00010dinhring scheme. FTB was separated from the NBC and now acting as an
independent commercial entity. The NBC transferred CR 10.3 billion to FTB to
meet an initial capital requirement. A working group, whose members are drawn
from the Ministry of Economy and Finance (MEF) and the NBC, has been
established to introduce a recapitalization bond. This issue will fully recapitalize
the FTB to CR 50 billion. Banking supervision will be further upgraded.

While much progress has been made in recent years in financial sector reform,
still many things remain to be done to support increased investment and high
and sustainable growth rate. Creating a modern and efficient financial system is
not an easy task. The government needs to fully understand what it needs,
which direction to go and how to get there.

The substantial progress that has been made in bank 00010dinhring will further
fuel the real economy through improved mobilization of financial resources and
the channeling of savings into investments. Lack of human resource capacity and
key legal infra010dinhre, as well as weak public confidence is a major impediment
to the development of the financial sector. The lack or inadequacy of laws
pertaining to accounting, insurance, negotiable ins10dments, secured

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transactions, commercial enterprises, bankruptcy, contracts and commercial
credit, also hamper the effective functioning of the financial sector. To address
these bottlenecks, the RGC has taken strides to upgrade banking supervision
capabilities and introduce a modern payments system. Dollar clearing and
settlement was initiated from January 2001 to facilitate payment operations and
shorten availability times. To this end, a draft Payments Law is being prepared
by the NBC to provide a legal basis for the payment system. An inter-bank
market arrangement will be established to ensure sound liquidity management.
Moreover, the RGC is determined to adopt a comprehensive commercial code by
the end of 2002.

Substantial efforts have been undertaken to improve prudential and

administrative regulations aimed at supporting the supervisory implementation of
the Banking and Financial Institutions Law. This includes the setting of prudential
limits for capital adequacy, solvency, liquidity and other parameters which form a
regulatory framework for the banking sector. The NBC will consider additional
regulations to ensure policies and procedures related to granting of loans and
making investment, evaluating the quality of assets and the adequacy of loan
loss provisions and reserves and write-off of bad debts, information systems, risk
management systems and internal control systems.

In an effort to promote development of interbank and money markets, the first

step is to introduce legal framework to underpin the interbank/money market
activities. The introduction of the law on negotiable instruments and payment
transactions will provide a good basis for improved payment system and liquidity
management. Several workshops including consensus-building seminars were
conducted; feedbacks were carefully incorporated in the draft law. After a long
process of consultation with all the stakeholders, the final draft was discussed
and approved by the plenary session of the Council of Ministers on May 09,
2003. The draft law is now waiting for the review and approval by the National
Assembly.

The banking sector been continuously strengthened through reforms in various

areas. In 2002, the outdated supervisory regulations were revised and replaced
by new regulations that are consistent with international standards. To enforce
prudential regulations the NBC has moved to carry out the task of full scope
inspection of banks, and up to now on-site inspection for six commercial banks
has been successfully completed.

The completion of bank re-licensing program introduced by the NBC has been
successfully revamped the banking system. Since 2002 16 commercial banks
were de-licensed and put under liquidation, a majority on a voluntary basis. The
whole process of liquidation of the closed banks is progressing well. As for the
liquidation of insolvent banks, the NBC has made various efforts to protect

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depositors' savings. During 2002-2003, the performance of licensed banks
improved greatly in terms of profitability. The banking intermediation and public
confidence has improved which resulted in an upward trend in deposits and
credit. Progress has also been achieved in restructuring the NBC's branches.
They now act as banks for the provincial treasury of the MEF, and contribute
thereby to improve cash management.

To help effective bank supervision, the new chart of accounts (COA) was made
available to banks by mid January 2003. For effective implementation of the COA
banks are classified into 3 tiers according to their accounting systems. By
September 2003 all tier I banks were almost completed to implement COA, while
a number of tier II and tier III banks still faced difficulties in complying with the
COA. The NBC has continuously examined the bank compliance with conditions
for implementation of the new COA. Corrective measures were promptly
introduced to the non-compliant banks with the aim of ensuring a full compliance
by year-end 2003.

To further promote financial intermediation, the government will take the

following actions:

• To promote bank lending, priority will be placed on establishing a legal

framework that ensures enforceability of financial contracts. Related laws
are currently going through the legislative process. Additional measures
needed to improve the legal environment regarding financial contracts will
be considered.

• With the strengthening of the supervisory capacity of the National Bank of

Cambodia (NBC), consideration is being given to reducing the present
highly conservative quantitative prudential regulations. A full on-site
inspection will be carried out for all commercial banks in 2004.

• Efforts will continue to help all banks fully implement the new chart of
accounts by the end of the year. A mechanism for assisting SMEs and
individuals who are not subject to the new Accounting Law should be
established to promote good financial reporting. Better provision of
information on their activities will make banks more willing to extend
credit to them.

• A concrete plan for privatization of the Foreign Trade Bank, specifying

measures to be taken accompanied by a timetable, will be prepared.

Access to credit in rural areas is key to broad-based economic expansion. The

RGC has several measures in this area: (i) transforming NGOs into formal
microfinance institutions (MFIs) or registered finance operators; (ii) improving

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supervision to mobilize resources; and (iii) reducing interest rates to increase
access by the poor to credit.

The NBC continued to transform NGOs in Cambodia into formal licensed MFIs or
registered rural financial operators. In the first nine months of 2003 the NBC
gave licenses to five MFIs and registered four NGOs as rural credit operators.
Presently, there are more than 100 rural financial operators including licensed
micro finances, registered and non-registered NGOs in which most of them are in
small size.

The introduction of an on-site and off-site inspection manual for MFIs in earlier
2003 has contributed to improvement in supervision of MFIs. To strengthen off-
site supervision by ensuring the quality and consistency of the financial
information submitted by financial institutions, a standardized new chart of
accounts has also been prepared. The new chart of accounts is gradually being
implemented by the licensed MFIs and those NGOs that intend to apply for a
license in the future. Likewise, the NBC has developed simplified reporting
formats for both registered and licensed institutions. For prudential purposes on-
site inspection has been conducted before granting license and registration
certificate as rural finance operators. The NBC has at the same time started an
eighteen-month cycle of on-site inspections for licensed institutions.

With the aim of reducing the interest rate on loans and therefore to improve
access of rural poor to banking services, the NBC has issued guidelines to MFIs
on the methodology to calculate the interest rate. In fact, rural finance operators
are requested to calculate their lending rate taking into account the repayments
of principal already made on that loan and should base the calculation only on
the loan outstanding. Customer, in turn, shall have credit amortization table. The
huge gap between demand and supply of funds represents a major constraint to
low lending rate in micro finance sector.

The regulation on the licensing and registration of MFIs aims therefore to

upgrade their legal status and strengthen their operations that will enable them
to attract more resources, either in the form of refinance assistance from the
Rural Development Bank (RDB) or as equity participation. Building the
institutional capacity of the NGOs that ha
 Box 1. Banking Institutions in Cambodia

As of 10 March 2005, there are 14 commercial banks, 3 specialized banks and 10 MFIs:

1. Commercial Banks

-Foreign Trade Bank (FTB; the only state owned commercial bank)
-3 Foreign Branch Banks: May Bank, First Commercial Bank and Krunk Thai Bank;
-10 Locally incorporated commercial banks: Advanced Bank of Asia, Cambodia Asia Bank,
Canadia Bank, Cambodian Commercial Bank (CCB), Cambodia Mekong Bank, Cambodian
Public Bank, Singapore Banking Corporation, Union Commercial Bank, Vattanac Bank and
ACLEDA Bank;

2. Specialized Banks:

-Rural Development Bank (RDB; the only state owned specialized bank)
-Cambodia Agriculture Industrial Specialized Bank
-Peng Heng S.M.E. Limited

3. Micro-financial institutions:

-Ennatien Moulethan Tchonnebat "EMT", Hattha Kaksekar, Tong Fang Micro Finance,
Thaneakea Phum Cambodia, Cambodian Entrepreneur Building, Seilanithih, Angkor
Microheranhvatho Kampuchea, Vision Fund and Credit.

Regarding the legal framework, there are as yet no laws on bankruptcy,

commercial enterprises, or secured transactions. These laws are still in draft at
the National Assembly awaiting adoption. They will be very important for building
the confidence and efficacy in the financial system, including the securities
market. The Inter-bank market is still inactive because of a lack of legal
framework and government-backed securities.

IV. The Insurance Sector

4.1. Insurance Market in Cambodia

At present there are only three non-life insurers operating in Cambodia: Asia
Insurance, Forte Insurance and Caminco. Cambodia Re is a national reinsurance
company operating in the country since 2003.

The gross non-life written premium of the three insurance companies increased
from US$8.8 million in 2003 to about US$10 million in 2004 or a 15-percent
increase of the market, compared to the 25% increase during the last 3 years.
Asia Insurance emerged as the number one player (US$4.2 million or 42% of

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market share, including about US$2 million fronting), followed by Forte (US$3.8
million or 38% of the market share) and CAMINCO (about US$2 million or 20%).

Future growth prospects of the general insurance industry in Cambodia will be a

function of the robustness of the economy, the strength and development of the
insurance sector, the Government’s ability to enforce compulsory insurance laws
and the private sector’s desire to insure locally. The insurance industry is likely to
further expand, provided that confidence can be restored.

4.2. Regulatory Developments

In 2002 the National Assembly of the Kingdom of Cambodia passed the Law on
Insurance. The Law and the implementing Sub-decree on Insurance require each
insurance company to have its registered capital of USD 7 million. To protect the
public from possible risks caused by the bankruptcy of the insurance company,
the law requires that an insurance company deposit 10% of its capital, i.e.
USD700,000 at MEF's account at the National Bank of Cambodia (NBC). As a
prudential measure, each insurance company is required to maintain a solvency
margin of 50 percent of the registered capital.

Having seen the difficulties faced by insurance companies to comply with the
requirements of the Law in terms of registered capital, on December 9, 2002, the
MEF issued an Instruction Circular to all insurance companies operating in the
Kingdom of Cambodia, which provides grand-fathering conditions to allow
insurance companies to operate in the insurance business. The Circular provides
a grace period of five years for insurance companies to increase their capitals
and maintain the solvency margin.

• Year 1: $350,000.00 (three hundred and fifty thousand US dollars);

• Year 2: $525,000.00 (five hundred and twenty-five thousand US
dollars)
• Year 3: $700,000.00 (seven hundred thousand US dollars)
• Year 4: $875,000.00 (eight hundred and seventy-five thousand US
dollars);
• Year 5: $1,050,000.00 (one million and fifty thousand US dollars)

For the first year, all insurance companies are required to deposit US$700,000 as
guarantee deposit at the NBC and US350,000 at a commercial bank to be eligible
for an operating license. For 2005, insurance companies are required to deposit a
further US$525,000. Totally the solvency margin of insurance companies
amounted to US$1.5 million.

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The MEF has developed new formula: solvency will, in the case of direct
insurance business, USD 1.5 million or 30% of net written premium income
(assets over liabilities) in its last preceding financial year, whichever is higher.

The non-life business in Cambodia has been growing at more than 25 percent
compound for the past 4 years, but growth for 2004 was only 15%. As incomes
rise, companies hope to see greater volumes personal and medical lines of
business. With the entry of private sector investors into the Cambodian market,
the property insurance market can be expected to pick up drastically provided
the Cambodian insurance market is well regulated and secure.

To protects businesses and individuals from catastrophic events, the MEF has
taken actions to revise the present law and sub-decree on insurance for
complying with the International Standard (IAIS core principles), adopt three
compulsory insurance on Motor vehicle; Passenger transport on land and
constructor's all risk liability and establish the National Bureau and the Insurance
Association for the implementation of the ASEAN Protocol 5.

However, with the increase in numbers of policies and given the inherent risks in
Cambodia, insurance companies will have to deal with the issues of setting
sensible premiums, management and selection of risks and customer servicing in
order to ensure a profitable and secure insurance industry for the future.

V. Capital Market Architecture

To develop the legal infrastructure for capital markets, the Ministry of Economy
and Finance (MEF) prepared a draft Law and sub-decree on Government
Securities and has taken the first step to make a Diagnostic and Policy Review
for the establishment of a securities market. To prepare a legal framework for
this purpose, the MEF is drafting the Non-Government Securities Issuance and
Trading Law. This will pave the way for the establishment of a stock market in
Cambodia by 2007.

The establishment of a non-government debt securities market however will

depend very much on the successful establishment of a broad-based government
securities market. The securities market must provide a reliable basis for pricing
non-government debt security issues. So, the Royal Government of Cambodia
will monitor and re-assess the timeframes in the Blueprint as the development of
the securities market proceeds.

For the efficient development of the capital market, it is very important to start
with government securities first. This assists in gaining the public investor’s
confidence and gets them into the habit of dealing with securities. To promote

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government securities it may be necessary to set up some special incentives to
attract investors.

The adoption and enforcement of the Non-Government Securities Issuance and

Trading Law will allow for the issuance and trading of Non-government Securities
and establishment an independent regulatory and supervisory agency, called the
Cambodian Securities Commission (CSC). The role of this CSC will be to regulate
both government and non-government securities.

The CSC will then be the only regulatory body which regulates and supervises all
kind of securities businesses. But the problem remains that the current Banking
law, which is based on universal banking system, allows the National Bank of
Cambodia (the Central Bank) to regulate and supervise all banks that trade
securities business under banking licenses.

The Draft Law on the Issuance and Trading of Non-Government Securities will
establish the legal framework for the basic components of a securities market,
which will be the primary market for offering and issuing new securities to public
investors. There will also be a secondary market, to enable public investors to
buy and sell issued securities. Finally, there will be provision for market
intermediaries or agents who facilitate the operation of both of these markets.

The regulations which the Royal Government of Cambodia will develop to

supervise these components of the securities market have aimed to ensure that
both the primary and secondary securities markets are conducted in a fair,
efficient and transparent manner. The major focus of the regulations is to protect
the interests of public investors and to reduce of risks to the capital market as a
whole.

The Draft Law on the Issuance and Trading of Non-Government Securities also
establishes a framework for allowing commercial enterprises to make initial or
new public offerings of securities, either for issue or sale, as a means of raising
new capital. This market is often referred to as the primary securities market,
which is the process by which a company, with the legal capacity to issue
securities to the public, offers to issue or sell new securities to public investors.

Under the Draft Law, an offer will only be a "public offering" if it is made to
members of the public and is capable of being accepted by any person or legal
entity with legal capacity to enter into a binding contract. An offer to a small
group of investors, particularly where the investors are already known to the
issuer, is more likely to be a private offer and issue, not covered by the
regulations. This distinction, to regulate securities trading only when it can harm
the public interest and not to burden individual entrepreneurs raising capital

16
through friends, family members and other personal networks, is adopted in the
securities laws of almost every developed country.

Additionally, the Draft Law will ensure that a company which wishes to make a
public offering of securities has the legal and commercial capacity to make such
an offer and to meet its obligations under the terms of the debt or equity
securities it issues. In addition, the quality of the governance of the company is
stipulated in the draft law, including the disclosure of the true financial condition
of the company, the prospects of the company and the disclosure of any risks
known to the company which relate to the company's prospects. The obvious
purpose of this is to protect investors from undisclosed risks and from being lied
to about what they are buying or being manipulated for unfair purposes. These
are also requirements set out in the securities laws of almost every developed
country.

In short, the law on securities will give Cambodia a fair, transparent, and
efficient securities market as good as that in any other Asian or western country.
Such a market will be an ideal instrument to facilitate the liberalization of
financial services and will bring Cambodia the level of investment it so
desperately needs to grow and to meet the needs of the Cambodian people.

VI. Bond market development

A comprehensive approach to foster an infrastructure for bond market might

include immediate to medium- and long-run measures as follows:

a. Improving infrastructures for the bond markets by establishing rating

systems, strengthening settlement mechanisms, and creating due diligence
processes;

b. Providing credit enhancement and developing credit guarantee mechanisms;

c. Promoting the efficiency and liquidity of the market by making market-making

arrangements available, and issuing government bonds as benchmarks in the
markets;

d. Laying a basis for stable financial markets by making effective use of foreign
reserves accumulated in the country to create short-term financial
arrangements; and,

e. Facilitating the development of the market with technical assistance from

advanced countries, and dissemination of information regarding the financial
profiles of high-performing companies.

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6.1. Existing Fixed Income Financial Instruments

Since November 2003, the MEF issued Riel-denominated Treasury Bills with
maturity of less than 91 days. The state-owned Foreign Trade Bank and Rural
Development Bank banks purchase T-Bills. However, T-Bills cannot be
recognized as a reserve asset.

The MEF also issued in 2002 recapitalization bonds recapitalize the Foreign Trade
Bank (FTB) (40 billion CRs), Cambodian National Insurance Company (CAMINCO)
(23 billion CRs), and the Cambodia National Reinsurance Company (Cambodia
Re) (28 billion CRs), but such bonds are not transferable.

6.2. The Challenges for Bond Market Development

The challenge of adopting the law is first to educate the public including relevant
government ministry officials about the concept and various aspects of
regulatory framework for new financial institutions. It is important to highlight 5
challenges to jump start the bond market:

1. Ensuring favorable conditions for bond market development: the past

experience has shown that macro-economic stability is critical in increasing public
confidence in bonds in general and saving bonds in particular. Firstly, the riel-
dollar exchange rates and secondly the inflation rate are crucial in instilling
confidence in the system. The public has always use this as reference as
profitability of their investment. In time of fluctuation, such as election time, the
public may shy away from saving bonds. For this reason, dollar-denominated
bonds could help to reduce currency risks.

2. Limited numbers of local investors and issuers: The number of potential

bond issuers in Cambodia is limited. The Company Act will be adopted to allow
for business incorporation. State-owned companies and local infrastructure
projects can be used for bond issuance. However, bond is critical for the
development of life insurance industry in Cambodia. Without financial
instruments life insurance companies will not be able to invest in long term
financial assets that meet their financial obligations. The interbank market should
be established to support for the development of the bond market. Moreover, a
number of laws, such as the Insolvency Law, the Negotiable Instruments and
Secured Transaction Law should be enacted to provide legal framework for bond
market development.

2. The issue of tax incentive is critical: As of now the incentive is only given
to banks in terms of tax incentive. Banks are not required to pay withholding tax

18
on bond yield, but insurance companies are required to pay 14% of withholding
tax. As bonds is also designed for investment by insurance companies, especially
life insurance then this issue need to be addressed. Moreover, Bond market
development is critical for life insurance. Life insurance companies will not be
able to kick start if there is no investment instrument in the country. The focus
on real estate as the investment instrument will lead to real estate bubble bust.
Another incentive is to allow bonds as reserve assets for banks.

3. Developing bond market infrastructure: The focus will be on establishing

a primary market, including methods of bond issuance, establishment of
benchmark yields, disclosure standards and credit ratings; then the next stage
will be to pay attention to the development of a secondary market in corporate
bonds that takes into account issues such as the type of market that operates
(wholesale, retail or both), reliable and efficient trading, clearance and
settlement, and market liquidity and risk.

For the development of efficient deep bond markets in the region, a conducive
environment should be established to ensure the active participation of both
issuers and investors as well as to tackle impediments to bond market
development in Asia. In this context, the following issues would merit further
consideration. In developing the bond market infrastructure the following issues
are important:

(A) Provision of Credit Guarantee

i. Effective Use of Credit Guarantee

The risks associated with bonds by some potential issuers have been perceived
to be prohibitively high by investors. The gaps between the perception of
investors and issuers of the appropriate risks and returns have been pointed out
as one of the major obstacles to fostering bond markets in Asia. It would
therefore be essential to develop credit enhancement measures to overcome the
“credit gaps” between potential investors and issuers, while such credit gaps are
expected to be mitigated as bond markets develop and as reliable credit ratings
are offered.

Provision of credit guarantee would be an effective measure to supplement the

creditworthiness of bonds, thereby encouraging both investors and issuers to
participate in bond markets, particularly in the initial stages of developing bond
markets.

ii) Active Use of Existing Guarantors

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The government and private issuers can resort to the multilateral financial
institutions such as the ADB and IBRD/IFC for guarantee operations. This
guarantee would supplement underestimated credit ratings so as to help
sovereign entities and private enterprises gain access to bond markets without
excessive interest charges.

iii) Using regional credit guarantee mechanisms

Using regional guarantee mechanism merits serious consideration to effectively

supplement the creditworthiness of potential issuers sovereign and cooperate
bonds, as well as create arrangements for securitization.

iv) Creation of Asset-Backed Securities Markets including Collateralized Loan

Obligations (CLOs) and Collateralized Bond Obligations (CBOs): To enable small-
and medium-sized issuers to tap the bond markets, securitization methods to
bundle up a group of assets and then sell the securities backed by cash flows
from these assets would certainly serve this purpose. Such structured financing
methods help repackage the loans extended to corporations as well as
debentures issued by corporations into asset-backed securities. The products
created by those structured financing techniques include collateralized loan
obligations (CLOs), which are structured bonds secured by a pool of existing
corporate loans or newly originated corporate loans. Collateralized bond
obligations (CBOs), which are bonds secured by a pool of existing or newly
issued corporate bonds, are also frequently marketed.

(B) Creating the Rating System

The development and utilization of credit rating agencies well acquainted with
the economic and social situation in the country would therefore be
indispensable to foster bond markets. Fair credit ratings would lay the
foundations essential for active regional bond markets. Through the following
measures, we would develop and strengthen local credit rating agencies:

i. Local credit rating agencies should be established and coordinate their

rating methods and rating scales;

ii. The Association of Credit Rating Agencies in Asia (ACRAA), established

in Manila in September 2001 with the assistance of the ADB, can be
used for credit ratings; This institution could also perform due
diligence, because some investors may require stricter disclosure and
may not be satisfied with credit ratings provided by local rating
agencies.

(C) Establishment of a Mechanism for Disseminating Information

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Companies with high financial standings are not necessarily known to investors,
who are not always well acquainted with the economic, social and legal
situations of bond markets. The government will therefore improve ways of
transmitting local information to the market.

One way of doing this would be to establish an electronic information network.

Information regarding excellent companies in the country as well as the
economic, social and legal circumstances surrounding these companies would be
transmitted through this network to markets within and outside the region

(D) Establishing the Settlement System

The settlement system ensures the interval between the transfer of securities
from the seller to the buyer (delivery) and the transfer of funds from the buyer
to the seller (payment). The strong linkage between the delivery and payment
would therefore lay the foundations essential for the development bond markets
as well as for the stability of financial markets. For those reasons, it would be
essential for a securities settlement system to create the strongest possible
linkage between delivery and payment such as delivery versus payment (DVP)
mechanisms.

In developing an efficient securities transfer system, a central securities

depository (CSD) would be put in place so that securities transactions could be
processed by means of book entry and that securities would be dematerialized
(they would exist only as electronic records.).

Furthermore, it would be essential for a settlement system to have a well-

founded legal basis including the legal enforceability of the rules and procedures
of the system.

4. Liquidity of the bond market is critical: Lack of secondary markets has

been pointed out as another serious impediment to bond market development.
This lack has impeded investors from selling bonds when they wish to do so.
Therefore, it is desirable to develop the secondary OTC market. Moreover, fiscal
management and predictable payment of interests is the most important aspect
of instilling public confidence in the system.

5. Institutional strengthening: Debt Management Office: so far there are 2:

Foreign debt and domestic debt Management Office. We have strong foreign
Debt Management Office at the Department of Investment and International
Cooperation. The domestic debt office is with the Department of Financial
Industry. It is important for fiscal and monetary policy to have a unified Debt
Management Office; its responsibilities and mandates should be restructured and
staff trained.

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6. Developing Corporate bonds: We should have a strong and powerful
regulator to supervise and monitor market participants. This is critical for
instilling public confidence and protecting public interests. If any harm occurs,
i.e. if the regulator is reckless, it would take years to remedy. It is important to
develop demand for and supply of corporate bonds through: the development of
financial incentives for issuing or investing in bonds; and investor and issuer
education about the benefits and risks of issuing and investing in corporate
bonds;

7. Bond Issues for Funding Infrastructure Projects: Private companies

that make investment in infrastructure projects should be encouraged to issue
bonds to finance the projects, in conjunction with bank loans. Furthermore,
companies with strong financial standing would issue bonds and then lend the
proceeds to local small- and medium-sized suppliers lacking access to the bond
markets. Those operations would also contribute to enhancing the efficiency and
depth of local bond markets in the region. Alternatively, government agencies
would issue bonds to co-finance infrastructure projects and on-lend the proceeds
to the company.

8. Developing Institutional investors: There is a strong connection in the

development of different types of financial markets. Pension Fund and Life
insurance vs. Bond Market.

6.2. Regional Cooperation within the ASEAN+3 Framework

Strengthening cross-border collaboration with ASEAN+3 countries within the

framework of East Asian cooperation is critical for Cambodia to enhancing bond
market development. The following are key areas for cooperation:

• Identifying the current regulation and supervision of corporate bond

markets within ASEAN member states, for the purpose of developing
common conventions and standards among ASEAN members;

• Harmonizing legal and regulatory frameworks within ASEAN;

• Providing for mutual recognition of rules and regulations within member

states;

• Adopting common accounting and audit methodologies;

• Harmonizing approaches to setting and obtaining credit ratings for issuers

of corporate bonds;

• Establishing linkages in payment and settlement systems; and

22
 • Harmonizing treatment of withholding tax treatment.

Under the ASEAN+3 Asian Bond Market Initiative, Cambodia has received
assistance from Japan for the development of the bond markets. A bilateral
Cambodia-Japan Cooperation Committee was established to coordinate this
initiative. A team from Keio University and Nomura Institute provide technical
assistance in the preparation for bond market development.

Japan and other more developed ASEAN+3 countries can provide assistance in
capacity building in areas of regulation and supervision to help ensure that
issuers of corporate bonds become more self-supporting over the long term,
through the development of an efficient, fair and orderly market.

The following is an indicative list of the topics to be pursued in each phase of the
bond market development:

Phase 1
Capacity Building (focus for
2003-2007)
• Legal & regulatory framework
• Investors’ education
• Market infrastructure for
trading, clearance and
settlement
• Methods of bond issuance
• Codes of conducts and
practices
• Establishment of benchmark
yields
• Development of secondary
markets
• Liquidity and risk
management
• Adoption of international
standards
Phase 2
Preparing for Cross Border
Collaboration
(for 2008 onwards)
• Establishment of common
conventions
• Linkages in payment &
settlement systems
• Harmonisation of regulatory
and legal framework
• Mutual recognition of rules &
regulations
• Removal of restrictions on
cross-border investment
• Adoption of common
accounting methodologies and
standards
• Harmonisation of withholding
tax treatment

7. Conclusion

Before introducing to the securities market potentially more volatile or unstable

financial instruments it is important to develop some fixed income financial
instruments first. Based on this premise Nomura Institute recommended the

23
development of a Government Saving Bond (GSB) was necessary. The features
of GSB would be as follows: - 1 or 2 year’s maturity, coupon bearer with a
physical certificate.

When the Government launches the GSB, it is important to assure the public that
the Government has the capacity to repay the principle and interest of GSB. So it
is rational to establish an Office for bond’s affaires to undertake all procedures
for repayment and to ensure transparency and efficacy (Debt Management
Office). After introducing GSB we can then start issuing debt instruments of State
owned companies like Electricity of Cambodia, Phnom Penh Water Supply. Then
the next step would be corporate bonds. As mentioned earlier, the Cambodian
economy is highly dollarised, so it is important to issue dollar denominated bonds
to avoid exchange risk and minimize other transactional costs that may occur.

At the same time, we need to look at the demand side (investors). Globally most
investors are typically ‘institutional’ but in Cambodia currently only commercial
banks could be classed as potential institutional investors. So it is crucial to
develop life and other insurance companies, and a Social Security Scheme to
support the development of Government securities.

In conclusion the Cambodian Government, while greatly appreciative of the

considerable assistance received to date, still needs more bilateral or multilateral
technical assistance (TA) to further firstly the bond market development and
then for the securities market as a whole which is scheduled for the end of year
2007.

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